IRS Wins Debt vs. Equity Case

A frequent area of dispute between taxpayers and the IRS is whether an indebtedness obligation should be treated as debt, or an equity investment, for income tax purposes. Taxpayers often seek debt treatment to obtain interest deductions, defer gain to a seller, or avoid gift treatment. Sometimes the underlying transaction is a straight loan – other times it involves a financed purchased of property.

The latter is what occurred in the subject case – a U.S. corporation purchased partnership units from a foreign corporation for a debt obligation. The debt was helpful since it provided an interest deduction to the U.S. obligor, deferred gain on the sale to the selling foreign corporation, and no taxable interest income to the foreign corporation obligee per qualification of the debt as tax-exempt portfolio interest debt.

This decision rested on whether sufficient questions of fact were raised to preclude summary judgment regarding claims of breaches of fiduciary duty. The beneficiary of an irrevocable trust sued her sister, one of the successor trustees, for breach of fiduciary duty, alleging that she had failed to distribute funds as provided for by the trust documents, failed to seek the return of $10,000 of trust assets wrongly retained by another of the successor trustees, and failed to return monies that she had purportedly misappropriated from the trust account prior to the settlor’s death.

In Rev.Proc. 2018-18, the IRS has released various tax rates, brackets, and threshold amounts for 2018, incorporating inflation adjustments and the new tax act. Some of the principal figures are as follows:

Numerous states have statutes that allow for the creation of self-settled discretionary trusts that are protected from claims of the settlor while allowing the settlor to be a discretionary beneficiary. Such trusts are likely valid for settlors who are residents of the particular state, the property in the trust is located in that state, and no other state has jurisdiction over the parties. While these states seek the trust business of persons outside of their borders seeking these benefits, the validity of these benefits to such person has been an unanswered question.

In a recent Supreme Court of Alaska case (Alaska being one of the states that allow for asset protection trusts), judgment debtors transferred Montana property to an Alaska asset protection trust after judgments were entered against them. . .